Rylstone Ltd has commenced operations with the following capital structure. Ryls
ID: 2667519 • Letter: R
Question
Rylstone Ltd has commenced operations with the following capital structure.
Rylstone Ltd: Statement of financial position as at date of incorporation
Assets
sundry assets 1 000 000
Liabilities and shareholders funds
Debentures, 8 percent (10 years) 300 000
Preference shares, 9 percent 200 000
Ordinary shares, issued and paid up 500 000
500 000 at 1 dollar -------------
1 000 000
--------------
The companys prospects contain estimates that will earn $ 100 000 in the first year and pay dividends of 10 % per share. Brokers anticipate that dividends will grow at 5 percent per annum. The shares are currently selling at $1. The company income tax rate is 30 cents in the dollar and the propotion of the tax collected from the company that is claimed by shareholders is 0.60. calculate the cost of capital for Rlystone Ltd.
Explanation / Answer
Income Tax rate = 30%
Equity Financing (E/V) = [500,000 / $1,000,000] = 0.50
Preferred Stock Financing (P/V) = [$200,000 / $1,000,000] = 0.20
Debt Financing (D/V) = [$300,000 / $1,000,000] = 0.30
Calculating Cost of Common Equity (Using Dividend growth model):
Dividend growth rate (g) = 5% per annum
Current Selling value per share (P0) = $1
Company Earnings = $100,000
Dividends pay 10% per share
Dividend per share = 10% of $1
Dividend per share = $0.10
Rate of return on Equity (RE) = [D0 (1+g) / P0] + 0.05
Rate of return on Equity (RE) = [$0.10 (1+0.05) / $1] + 0.05
Rate of return on Equity (RE) = [$0.105 / $1] + 0.05
Rate of return on Equity (RE) = 0.155 (or) 15.50%
Cost of Debt (RD) = 8%
Cost of Preferred Stock (RP) = 9%
Weighted Average Cost of Capital Calculation (WACC):
WACC = (E/V) * RE + (D/V) * RD (1-Tc)
WACC = [(0.50 * 0.155) + {0.30 * 0.08 (1-0.30)} + (0.20 * 0.09)]
WACC = [0.0775 + {0.30 * 0.056} + 0.018]
WACC = [0.0775 + 0.0168 + 0.018]
WACC = 0.1123 (or) 11.23%
Cost of Capital for Rlystone Ltd. = 11.23%
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